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July 7th 2022

10 min read

How prepared are you for the new SEC 2a-5 and 31a-5 rules?

The compliance date for the new Good Faith Determinations of Fair Value rules is fast approaching, and fund managers will need to make sure they’ve implemented appropriate pricing processes by September 8, 2022.
Fair Value Pricing

The Securities and Exchange Commission (SEC)’s new rules, 2a-5 and 31a-4, adopted under the Investment Company Act of 1940, officially came into effect on March 8, 2021, and we’re now coming to the end of the 18-month transition period the SEC allowed to give all those impacted time to prepare.

Under the Investment Company Act, funds must value their portfolios using market prices or, where the investments are illiquid and hard to value, using good faith fair value calculations. The new rules, 2a-5 and 31a-4, refine the existing parameters and lay out a principle-based approach for determining fair value.

Here’s a breakdown of the new rules and how you can get ready before September 8, 2022.

 

The new SEC fair value rules broken down

What are the new rules?

Two new rules have been adopted under the Investment Company Act: Rule 2a-5 and Rule 31-4.

Rule 2a-5:

Under the new rule, funds and investment companies will be required to:

  • Periodically assess and manage valuation risks

Funds will need to assess and manage valuation risks related to their investments at appropriate periods.

  • Establish and apply fair value methodologies

Funds will be required to apply fair value methodologies appropriate to the investments, periodically review the accuracy and choice of those methodologies, and monitor changing circumstances that may alter fair value requirements.

  • Test fair value methodologies for appropriateness and accuracy

The board of directors, or their designated valuer, must identify testing methods and how often they are to be used to ensure the continued appropriateness and accuracy of the fair value methodologies.

  • Evaluate pricing service providers and challenge pricing

The board of directors, or designated valuers, of funds using pricing services must implement processes for assessing and scrutinizing any pricing service providers they use, and for challenging pricing determinations appropriately.

Rule 31a-4:

  • Maintain appropriate records to support valuations

Fund and investment companies’ boards of directors, or their advisers, will be required to keep appropriate records to support their fair value determinations. 

 

Who do the new rules apply to?

The new rules apply to all registered investment companies and business development companies, as well as their advisers.

 

What are the key dates?

  • December 3, 2020: The SEC announced it will adopt the new rules.
  • March 8, 2021: The new rules came into effect.
  • September 8, 2022: All those affected must comply with the new rules.

 

Why has the SEC introduced the new rules?

On announcing the adoption of the new rules in  December 2020, Jay Clayton, Chairman of the SEC, said: “Today’s rule is designed to improve funds’ valuation practices, including by providing for effective board oversight, for the benefit and protection of fund investors.”

 

How can you make sure you’re ready to comply?

In practice, complying with the new ruling will require funds and investment companies to implement technology capable of automating pricing workflows, or else they risk falling short – of both the new regulations and their competitors.

The landscape of fair value pricing solutions is changing rapidly as providers harness new technology to meet new regulatory and market challenges. One company at the forefront is TTMzero, a member of the United Fintech Group with a presence in Berlin, Copenhagen, Madrid, London, and New York.

“The new rules don’t have to be a headache. In fact, complying with them can be virtually effortless,” says Simon Ullrich, Founder and Managing Director at TTMzero, whose fair value pricing solution, first introduced in 2013, is delivered via an API and enables transparent daily fund valuations based on proven methodologies.

“To achieve accurate fair value pricing at the necessary frequency, automatically apply tried-and-tested valuation methodologies, and keep records of the pricing calculations and methodologies used, you need to make the most of the technology that is now available.”

“The new rules recognize that many funds use third-party pricing services to perform the fair value calculations, and anticipate that many more will now choose to do so. While some investment banks provide this sort of valuation service, there are benefits in selecting partners who are truly independent.”

Under the new rules, fund managers and company directors will need to oversee the selection of these services and evaluate them regularly.

“Valuation risk will always exist. But fully independent companies such as TTMzero have no conflict of interest whatsoever – we don’t engage in any trading activity and there’s no incentive at all to manipulate prices one way or another. At TTMzero, our pricing technology has been stress tested over and over again.”

TTMzero, after working with the largest auditors, has put its fair value pricing tool through the most rigorous testing possible.

As well as transparent, accurate pricing that meets the new requirements, fund and asset managers need the process of implementing the new pricing workflows to be as stress-free as possible:

“At TTMzero, we pride ourselves on offering a cost effective and highly individual service. We’re not the biggest, but we make sure we’re there for our customers every step of the way to help them integrate the solution into their process so it works seamlessly,” says Simon.

“Our API means there are zero headaches when working with whatever legacy systems funds are working with. Our solution is highly scalable and runs on an AWS (Amazon Web Services) infrastructure. It’s this flexibility and potential for customization that our customers are looking for.”

TTMzero’s products cover the whole lifecycle of financial instruments, and their fair value pricing solution addresses all the areas of the new rules.

 

How TTMzero Fair Value Pricing helps you comply with the new rules

Requirement 1: Periodically assessing and managing valuation risks

The new rule identifies a number of possible valuation risks, including using service providers with “more limited expertise in relevant asset classes” and that “the methods for determining and calculating fair value are inappropriate or […] not being applied consistently or correctly”.

Trusted by tier one investment banks and some of the largest asset managers in the world, TTMzero’s pricing technology includes an extensive selection of algorithms and industry-standard quantitative models. It’s transparent and proven.

Requirement 2: Establishing and applying fair value methodologies

The valuation service helps evaluate portfolios with accurate prices based on proven methodologies. Most TTMzero customers request valuations on a daily, or twice-daily, basis. They send their list of holdings via an API request, and the tool automatically calculates and sends them fair values for all the instruments they hold, using tried-and-tested algorithms and pricing models.

Requirement 3: Testing fair value methodologies for appropriateness and accuracy

TTMzero’s Fair Value Pricing is proven – it has gone through several audits with large auditors, who have looked at the independent mark-to-market prices used and performed rigorous stress tests.

Requirement 4: Pricing service evaluation and price challenging

Whenever customers see a price for a certain instrument that differs from the value TTMzero has provided, they can reach out to the customer success team, who will take them through every step of how the valuation was made – from the input market data to the methodologies used to arrive at the valuation.

Requirement 5: Recordkeeping

TTMzero’s platform automatically stores every data point, relevant input data, calculation, and methodology used in immutable databases, meaning nothing can be altered after the fact.

 

Automated fair value pricing that plugs right in

At United Fintech, our goal is to make it easy for financial institutions to harness the latest technology to get the edge on the market – by being a one-stop shop for the best and latest tech solutions.

Learn more about TTMzero’s Fair Value Pricing – a tool providing independent, transparent valuations of illiquid and hard-to-value instruments that don’t have observable market prices.

 

Sources:

SEC. Good Faith Determinations of Fair Value.

SEC. SEC Modernizes Framework for Fund Valuation Practices.

Deloitte. Mutual fund directors and investment advisers digest.

PwC. SEC Final rule 2a-5 – Good faith determinations of fair value.

 

 

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